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What are the underlying policy choices responsible for the recurring currency disputes

Simon J Evenett

Once dismissed as self-serving grandstanding by the Brazilian finance minister in 2010, claims that the world is closer to a currency war have returned. This time, the proximate cause appears to be the publicly-stated policies of the new Japanese government aimed at shaking off a decades-long economic malaise. Is this another flash in the pan—or are there deeper factors at work?

The recurring ‘currency wars’, however, are not random, inconsequential events. Until the economies of the major trading powers recover or there is a significant shift in national policy mixes, we should expect the currency war to keep breaking out like a rash.

There is an air of resignation—almost of inevitability—to some commentary on today’s currency war. Broken down, the argument goes like this. It starts by noting the widely shared view that one of the major lessons from the 1930s is that economic crises such as these require active monetary policy. Pumping liquidity into the banking system, etc, is seen by many as a legitimate role of central banks during crises.

When interest-rate differentials and exchange-rate movements have adverse knock-on effects for trading partners, then accusations of currency war follow. While the major industrial economies remain in the doldrums, differences in timing of monetary policy easing and the like will result in repeated charges of beggar-thy-neighbour policymaking and so the currency war reads like a book with many chapters. Before unpacking this chain of logic a little more, it is first worth noting that the apparent inevitability has led to the five rationalisations for the current currency war.

l The ‘just following orders’ defence: This defence was put well by Philipp Hildebrand, the former head of the Swiss National Bank, in an oped piece in FT. In his view, central banks haven’t declared war on trading partners. Rather they’ve sought to revive their national economies taking steps—and this is important—that are entirely consistent with their legal mandates. Of course, critics will hardly be satisfied (a) as the cross-border adverse knock-on effects of monetary easing are what they are, (b) just because something is allowed doesn’t mean it is the right thing to do and (c) that this defence demonstrates just how parochial central bank mandates are.

l The ‘no malice’ defence: In their statement last week the G7 implicitly proffered this defence. Monetary policy that does not seek to target